Foreword

The impacts of physical climate risks are no longer a future concern but are already materialising across the globe. The increasing frequency and intensity of extreme weather events are a growing source of macroeconomic and financial risk, with global losses now exceeding USD 200 billion annually. This technical note, prepared at the invitation of the French G7 Presidency, provides empirical insights into the transmission channels of these events. Drawing on 31 case studies from 28 economies, the note highlights how shocks propagate through the economy and the financial system, affecting output, inflation, and financial stability.

Executive summary

Annual global direct damages from weather-related events have more than doubled since the early 2000s, reaching over USD 206 billion in 2025. Despite the scale of these damages, gaps remain in understanding how these shocks propagate. Extreme weather events can generate substantive macro-financial effects, including stagflationary pressures. The impacts are propagated through supply channels, such as damaged productive capital and labour supply disruptions, and demand channels, including income loss and reduced tourism consumption. The report recommends that central banks and supervisors improve data availability, expand access to insurance, and invest in risk reduction and adaptation to mitigate these potential impacts.

Extreme weather events and economic framework

The economic impacts of extreme weather are determined by three interrelated dimensions: hazard, exposure, and vulnerability. Hazard refers to the nature and intensity of the event; exposure captures the presence of people and assets in affected areas; and vulnerability reflects the susceptibility of those assets to damage. The framework identifies economic transmission channels (supply and demand), financial transmission channels (credit, market, and liquidity risks), and resilience measures (fiscal space and insurance). While impacts can damage capital in the short term, they can also lead to long-lasting effects on human capital and productivity.

Extreme weather events can propagate to the economy via supply and demand channels

Supply factors include the destruction of productive capital, particularly in agriculture and infrastructure. In Ecuador (2024) and Zambia (2023), droughts reduced hydropower generation to 20-25% of total capacity, leading to power rationing. Labour supply is another critical channel; in Pakistan (2022), floods disrupted employment for approximately 4.3 million workers, representing 20% of the pre-flood workforce. Logistics disruptions further amplify these effects; for example, the Durban food basket increased by 13.6% year-on-year following the 2022 floods due to damaged port infrastructure.

Demand channels operate through income, wealth, and confidence effects. In Greece and Italy (2023), floods led to a 30-50% reduction in seasonal hiring. Tourism-dependent economies face significant hits; Jamaica (2025) saw a near 40% year-on-year decline in visitor arrivals following hurricane damage. National and international spillovers also occur; in Pakistan (2022), exports fell by 13% while imports of food and energy rose by over 60%, widening the trade deficit. These supply and demand interactions often result in a stagflationary impulse, combining weaker economic growth with higher prices.

Extreme weather events can also be transmitted to the financial system

Financial institutions are affected through traditional risk channels. Credit risk rises as disruptions to production and income weaken borrowers’ repayment capacity, increasing non-performing loan ratios. In Pakistan (2022), substantial increases in non-performing loans were observed in the banking and microfinance sectors. Collateral values can also deteriorate; banks in Germany (2021) experienced a contraction in collateral values in flood-affected regions. Liquidity pressures arise from emergency withdrawals and payment deferrals, though these are often transitory. Feedback effects occur when banks tighten credit conditions in response to higher risks, potentially reinforcing economic downturns.

Resilience of the economy

The capacity to absorb and recover from losses is determined by resilience factors such as adaptive infrastructure, insurance, and fiscal space. Examples of protective infrastructure include the Netherlands’ storm surge barriers and the Thames Barrier in London. Innovative financial instruments, such as natural disaster clauses in debt used by Grenada and Barbados, allow for automatic debt service deferral. Insurance plays a vital role; in France, the Cat-Nat regime provided compensation of approximately €1.2 billion after 2016 floods. However, insurance coverage gaps persist, especially in developing economies where the protection gap is wider. Fiscal space is also a critical determinant; while advanced economies can ramp up public expenditure rapidly, developing nations are often constrained by limited fiscal buffers.

Extreme weather events can impact price stability and resilience of the financial system

Central banks consider extreme weather shocks when they persist or trigger second-round effects on inflation. In 2022-2023, the State Bank of Pakistan raised its policy rate by 825 basis points to 22.0% to contain inflationary pressures exacerbated by floods. Ensuring financial stability involves supervisory flexibility and monitoring. In Brazil (2024), the central bank introduced temporary regulatory flexibilities, such as relaxed loss provisioning rules, to maintain the functioning of the financial system in affected regions. Integrating extreme weather effects into financial stability monitoring and stress testing is highlighted as a necessary step for central banks and supervisors.

Conclusion

The note concludes that extreme weather events affect the economy and financial system through multiple, complex transmission channels. While the case studies provide valuable empirical evidence, significant gaps remain in measuring cross-border spillovers and second-round effects. Strengthening analytical frameworks and improving data quality are identified as key priorities for future work. The NGFS encourages continued effort to identify large financial exposures and vulnerabilities to support more effective policy responses.